Money talks and London listens to the yuan

Currency is fast becoming a key topic of conversation for bankers, reports Diao Ying in London.

The fashionable youths in hot pants flocking to high-end department stores in London and bankers in dark suits walking in and out of skyscrapers in the financial district have one thing in common, a growing interest in the Chinese currency.

During the recent holiday to celebrate the Diamond Jubilee of Queen Elizabeth II, Harrods, a department store known for its ties with the British royal family, launched its own Sina Weibo, a popular Chinese social media platform, to attract more Chinese customers. Shoppers can find "the very latest, limited edition and exclusive products", with Hermes, Chanel and Louis Vuitton among the most popular brands, according to the store's spokesman.

More than 100 UnionPay payment terminals in the store also help to make Chinese shoppers feel more at home. Through the machines, part of China's unified bank card network, Chinese visitors can pay for their purchases with the same cards they use at home.

A few streets from Harrods, a billboard featuring a green jade dragon shaped like the yuan symbol stands outside a bank. The ad reads: "A new global currency is emerging. Be part of it." The commercial is for HSBC, a bank rooted in the silk and tea trade between China and Britain in the 19th century.

The UnionPay terminals, the jade dragon advertisements and the shops on the streets of London offering exchange services between the British pound and the yuan are the tip of the iceberg in the biggest story in the financial markets today: the internationalization of the Chinese currency.

As people search for a bright spot amid sluggish economic growth in the West, beset as it is by the European debt crisis, companies, investors and financial institutions are increasingly focused on the yuan. From Beijing to Hong Kong, Tokyo to London, policymakers and businesses are part of the push.

There are several forces driving this move, both at home and abroad. The People's Bank of China has made several moves this year to liberalize the exchange rate; George Osborne, the UK chancellor of the exchequer, took the initiative to develop London into an offshore trading center for the yuan earlier this year; and this month, the yuan became convertible with the Japanese yen under an agreement between the Chinese and Japanese governments.

"All of it demonstrates that the Chinese government is pushing forward the internationalization of the yuan and encouraging the use of yuan offshore. That will help the global economy in many ways," said Adam Tyrrell, head of European capital markets for Standard Chartered in London.

Greenback to redback
These initiatives will have a profound influence on the development of trade. For instance, China and Europe are each other's largest trading partners, but, up till now, the bulk of that trade has been settled in the US dollar. If a Chinese company buys pork from a UK company, it does not buy and sell in yuan, the pound or the euro. It settles in dollars.

That paradox is changing. Now the same pork company can open a yuan account at a British bank such as HSBC or Standard Chartered, or a Chinese bank that operates in Europe, such as Bank of China or Industrial and Commercial Bank of China, and can then invoice the goods or settle the deal with its Chinese clients in their national currency.

The advantage of this is clear: Settling in yuan helps both sides to avoid foreign exchange risks and reduces transaction costs. For instance, in 2008, many companies in southeast China had to lay off workers and close factories because they were losing money through currency appreciation. That situation would have been different if the contracts had been signed in yuan, because the agreements would have a fixed value no matter what the change in the exchange rate.

The initiative can also benefit companies outside the European time zone, given London's position as the world's foreign exchange center. "The beauty of London is not just about London," said Patrick Law, Hong Kong-based managing director and head of trading for Greater China at Barclays. "If you look at the London time zone, it covers both the northern and southern hemispheres." And that means it will also help facilitate business between China and Africa and the Middle East.

"Africa is a very interesting market to look into because China and Africa have a lot of business together," Law said. He added that Barclays, a bank with strength in commodity trading, began to conduct trade between the South African rand and yuan from April.

Uncle Sam to dim sum
The internationalization of the yuan will also offer a new platform for companies and investors looking for alternative methods of financing.

The "dim sum bond" got its name from delicacies in Chinese cuisine such as spring rolls, shrimp dumplings and steamed buns. The name has been appropriated for fixed income denominated in yuan and was started in Hong Kong when the city became the first offshore center for yuan trading. The bond has become increasingly popular outside Asia and grew rapidly in Europe last year, according to Standard Chartered's Tyrrell.

British banks were involved in five dim sum bond deals with European companies and financial institutions last year. It has also been involved in three client deals so far this year, according to Tyrrell: "Over time, as the yuan is used more, more European corporates and financial institutions will be interested in transacting in yuan, either for their China business, when they can remit onshore, or as a way of diversifying their investor base."

The motivation for getting involved in dim sum bonds is also changing, he said. When the yuan market first developed offshore, a lot of investors were looking for a currency play rather than a bond play. At first, investors were looking to invest in the currency because they thought it was going to appreciate.

"Over time, it is developing into a more mature bond market," said Tyrrell. "It will tend to be more driven by traditional bond market influences."

That's particularly true this year, because of the fragile state of the global economy. If the investor sentiment is not there, there will be fewer bond issuances, according to Tyrrell. "There is definitely momentum in the yuan. It will not stop. It will grow," he said.

Chances and problems
Given the fact that the yuan is still not fully convertible, there is still a lot of work to be done to encourage people to hold it and conduct business with it, as they do with dollars.

The main issue for London as it attempts to develop into an offshore yuan trading center revolves around the lack of liquidity. That's due to both a paucity of knowledge about the yuan market and the limits of infrastructure to facilitate trade flows.

"Without liquidity, we cannot grow the pie and make the market more efficient," Law said. "Everybody is definitely very interested. The current situation is that people have just started looking into it," he said. "The involvement is still relatively small, but the amount of interest is actually very high."

Some observers have suggested that the pool of yuan liquidity in London can grow through a huge variety of sources. For instance, Standard Chartered recently issued yuan-denominated European Commercial Paper to investors in Europe.

"ECP is issued to investors. Then Standard Chartered holds the liquidity in yuan and can use that for trade finance. This will help to increase trade flows with China for European clients," Tyrrell said.

"As investors become more comfortable holding yuan, it will help build liquidity here."

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